Bank of America said the US could see a significant drop in inflation without hitting a recession.
Strategists pointed to the inverted Treasury yield curve, the notorious measure of bond market stagnation.
But this time, the index points to a strong drop in inflation, not the economy.
Inflation could head down significantly, and prices could drop significantly without the US having to deal with a recession, according to Bank of America.
Strategists pointed to the inverted 2-year and 10-year Treasury yield curve, the notorious bond market recession scale which has successfully predicted many downturns, most recently in 1990, 2001, and 2008. When short-term yields are higher than long-term bond yields, it has historically indicated that investors believe a downturn is about to happen.
The difference between the two-year and 10-year Treasury yields is just that Drenched in full proportion point last week, marking the largest reversal in more than 40 years.
This time, though, the index is more reflective of the upcoming hard landing in inflation, the bank said, and the US economy is likely still on track to avoid a sharp deflation.
“While curve inversion hears of historical extremes have had higher recession probabilities than models, we believe the curve shape is more a function of lower inflation expectations than a deterioration in growth,” the strategists said in a note on Thursday. “An underhand look suggests that real rates forwards do not value higher recessionary risks and instead may reflect expectations for a softer landing against the consensus.”
The bank said that was because forward real yields, which represent market expectations for inflation-adjusted bond yields, have seen only a “modest decline” in the short term.
This suggests that investors expect the Federal Reserve to slowly ease interest rates – a move they are unlikely to do if the economy faces high risks of recession.
“The inversion of the curve at historically extreme levels right now does not reflect rising recession risks, but instead is largely related to expectations of cuts along with close to target inflation,” the strategists added, referring to the Fed’s 2% inflation target.
Investors have been eyeing a potential recession for the past year as the Federal Reserve aggressively raised interest rates to tame inflation, a move that threatens to tip the economy into recession.
Rates are now at their highest level since 2007, with Federal Reserve officials suggesting more hikes are to come later this year. The markets have an 87% chance The Fed will raise interest rates by another 25 basis points at its policy meeting in July, a move that would raise the federal funds rate to 5.25-5.5%.
Meanwhile, the Federal Reserve Bank of New York rates A 71% chance of economy It will head into recession by next year.
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